Introduction: The Bakken shale play is one of the biggest in the U.S., but is absolutely dwarfed by a shale play in Russia. Its name is Bazhenov and it is located in Western Siberia. The Russian government hopes to unlock its potential using tax breaks that it announced earlier this year to coax companies to invest in cutting-edge drilling technologies. According to Oswals Clint, Sanford Bernstein’s lead international oil analyst, it “covers 2.3 million square kilometers or 570 million acres, which is the size of Texas and the Gulf of Mexico combined,” an area 80 times bigger than the Bakken.

The region which is covered by the Bazhenov has many cracks and fractures which could make its oil flow more readily, and therefore production much cheaper. The advantage of the Bazhenov in comparison to the ice-packed Arctic waters with the expensive icebreakers, drillships and subsea pipelines is that it is onshore and underlies an area that is already networked with pipelines serving mature, conventional fields. A couple of test wells have been drilled in the region which operated at 400 bpd, the same as an average Bakken well. Although the Bazhenov is new to many of us, geologists have been studying it for at least 20 years; however, it is only in the last few years that the technology and expertise necessary to drill the oil has been developed.

The national subsoil agencyRosnedra estimates that the Bazhenov formation in West Siberia may hold between 25 billion mt (182 billion barrels) and 50 billion mt of recoverable reserves.

The Bazhenov formation, like the similar Achimov and Tyumen formations, is below conventional oil layers, differs from them by geological composition and is challenging due to narrow pay-zones and low permeability. But perhaps the most formidable challenges are an extremely low recovery rate as well as high decline rates that translate into a high lifting cost. At present, recovery rates at different tight oil projects in Russia are just at between 2% and 8%, according to Lukoil which estimates that tight oil reserves in the country amount to as much as 62% of its total reserves.

Lifting costs of tight oil are estimated at between $14/bbl and $40/bbl, according to data by different companies. In comparison, the lifting cost of some new conventional oil projects in Russia exceeds $10/bbl, while average lifting costs are much lower and stood at below $3/bbl for Rosneft and $5/bbl for Lukoil, according to second quarter financial reports of the two biggest oil producers in Russia.

While developing the Bazhenov formation has so far been unprofitable, recent success in developing tight oil reserves in the U.S. is expected to give an impetus to the development of tight oil reserves elsewhere in the world, including Russia. Studies have showed that the geological structure of Bazhenov is very similar to that of the liquids-rich Bakken play in the U.S. and that technology and experience from the U.S., such as horizontal drilling with multiple hydrofracking, could be deployed in Russia. The use of horizontal drilling will grow faster in Russia than in the United States, where it is helping to drive a boom in shale oil and gas, the CEO of Russia's biggest driller, Eurasia Drilling said. "Growth in the U.S. will not be so huge as the growth of horizontal drilling in Russia," Alexander Djaparidze, who helped found the company in a buyout of No. 2 oil producer LUKOIL's drilling assets, said in an interview.

In the space of last year, Eurasia Drilling, which acquired Schlumberger's Russian drilling assets in April 2011, reported horizontal drilling doubled from 2010 to nearly 900,000 metres.

The beneficiaries from the upcoming development of this huge formation are both the operators and the oilfield-services-related companies. Most investors focus on the operators, but I believe they miss a big part of the whole picture. This is why I decided to capture the oilfield services related companies too. "The early bird catches the best food," as all investors know very well. So I believe it is wise for an investor to be an early bird and have a closer look on the involved parties now that it is still early. Once the development starts in 2013, the investors may have to pay a higher price for the companies below.

The operators

1) Statoil (OSE:STL)(STO) signed a cooperation agreement with Russia's state controlled oil company Rosneft in May 2012 along with shareholder and operating agreements in late Aug 2012. The companies have agreed to jointly explore offshore frontier areas of Russia and Norway and to conduct joint technical studies on two onshore Russian assets. Under the agreement, Statoil and Rosneft will set up joint ventures, with Statoil holding 33,33% in each. In addition the two companies will conduct joint technical studies on two onshore Russian assets. One of these assets is the Bazhenov formation at the North-Komsomolskoye field in West Siberia where Statoil can contribute with experience and competence from both Brazil and the Norwegian continental shelf to unlock the potential of this significant non-producing greenfield.

2) Exxon Mobil (XOM): Exxon Mobil Corp who has vast experience fracking for tight oil in the US, formed a partnership with Rosneft in June 2012. As part of the deal, Rosneft has also acquired 30% of a Texas tight oil project in order to receive direct experience with fracking technology. The Joint Venture will start drilling in 2013. Rex Tillerson, the CEO of Exxon, is excited by the potential of the Bazhenov play, but admits that the tax breaks will be vital. “The in-place potential is enormous -- billions of barrels. The real issue is can we develop it in a cost effective way? -- same as the issue we have with tight oil and unconventional resources in North America.”

3) Rosneft: Rosneft is Russia’s largest oil producer, with operations focused on the exploration, production and marketing of oil and oil products, with some gas operations as well. The company has extensive reserves, estimated in 2007 at 17,513 million barrels of crude oil and 711 billion cubic metres of gas. The Russian state owns 75% of Rosneft with approximately 15% traded. It is listed in Russia on the RTS (ROSN) and Micex (ROSN) with American Depository Receipts listed in London (ROSN). It is also worth noting that according to Reuters, Rosneft announced back in June 2012 that it would spend up to $2 billion to buy back shares from minority investors.

4) Gazprom-Neft: GazpromNeft is a major Russian energy producer focused on exploration and production of oil and gas, with additional operations in oil and gas field servicing, refining, and marketing. GazpromNeft in 2010 achieved 52.8 million toe produced and refined 37.9 mln tonnes. It partly or wholly owns three refineries in Russia and two in Serbia and has an extensive retail station network. Majority owned by Gazprom, Gazprom Neft’s shares are listed on Russia’s RTS (SIBN) and Micex (SIBN), and is becoming a significant international player with projects in the Middle East, Africa, Europe and Latin America.

According to the latest news from the Ukrainian newspaper Kyiv Post as of Nov 2012, Gazprom Neft believes its joint shale oil project with Shell is the most promising at the Bazhenov formation in Western Siberia. Their geologists say that this might be the most promising block in the Bazhenov Suite of Western Siberia. Gazprom Neft specialists visited the U.S. to look at Shell's work at similar formations. For now they are planning to drill wells at their project and only then decide on its future," the Russian oil company's head of strategic planning, Sergei Vakulenko, said in a conference call.

According to Gazpromneft figures, the aggregate resources of the Bazhenov formation in West Siberia are 89 billion tons of oil. The level at which that resource becomes commercially viable will depend on both the availability of technology and on the tax regime in effect. "We cannot extract all of the oil, both conventional and unconventional, but we need to try," General Director Aleksandr Dyukov said last week.

5) Gazprom: Gazprom is the world’s largest gas company, and one of the worlds preeminent energy companies, focusing on the exploration, production, transmission, storage, processing and marketing of gas for customers in Russia and around the world. It owns a majority stake in GazpromNeft which plans to be directly engaged with Bazhenov. Gazprom has the world's largest gas reserves (estimated at 29.85 tcm) and the worlds largest gas transmission system. The Russian government owns 50.02% of the company, with the rest listed in Russia on the RTS (GAZP) and Micex (GAZP), with American Depository Receipts listed in London (OGZP).

6) Lukoil: Lukoil is a private Russian oil company. “Lukoil is already using horizontal wells and multistage fracking to support its West Siberian production, and therefore may be the earliest, clearest beneficiary” of the tax breaks," Paul Smith, a Moscow-based oil and gas analyst at Citigroup said recently. Lukoil subsidiary Ritek produces about 2,000 barrels a day from the Bazhenov formation in “experimental” projects, spokesman Vladimir Semakov said by phone. It is listed in Russia on the RTS (LKOH), in Micex (LKOH) and in London Stock exchange (LKOD).

The Oil Field Services-Related Companies

As drilling will become deeper and heavier, I also believe that several oil service companies will be the major beneficiaries of the upcoming drilling spree into the offshore and onshore prospective oil plays of Russia. Let's have a closer look on them:

1) Eurasia Drilling positions itself as Russia's only domestic driller with offshore experience, with two jack-up rigs — like mobile drilling platforms — operating in the Caspian Sea and a third under construction, as well as a contract for platform services at Lukoil's Korchagin field.

Eurasia made its first acquisition outside the former Soviet Union in July 2012, buying two rigs in Iraq's semi-autonomous region of Kurdistan with a commitment to purchase a third. In Europe, Eurasia Drilling is watching potential shale plays, in particular in Poland as France decided not to do shale gas finally. Its onshore drilling services include construction of production, exploration and appraisal oil and gas wells and certain other types of wells, ranging 1,200 meters to more than 5,000 meters. Its offshore division constructs oil and gas exploration and production wells in waters with depths of up to 350 feet in Russian, Kazakh and Turkmen waters of the Caspian Sea. Eurasia Drilling trades at the London stock exchange with the ticker EDCL.

2) C.A.T. oil AG, together with its subsidiaries, provides oil and gas field services primarily in the Russian Federation and Kazakhstan. The company offers various services, including hydraulic fracturing, an oil and gas production simulation technology for pumping liquids and chemicals into a well to create fractures in the reservoir; side tracking/inclined drilling, a process of drilling of a new wellbore from the upper section of an existing well that has stopped producing hydrocarbons; and conventional drilling, a technology of drilling vertical, inclined and horizontal wells for extraction of oil and gas with a depth of up to 5,000 meters. Its services also consist of remedial/squeeze cementing, which includes sealing of casing to prevent cross-flows by insulation of oil zone from water zone to restore production; nitrogen services; workover, a process of performing maintenance or remedial treatment of oil and gas wells to boost productivity, delay decline, and/or put idle wells back to production; and geotechnical services, such as reservoir modeling/engineering, geologic modeling, seismic reservoir characterization, field appraisal/economic evaluation, 2D/3D seismic survey, seismic data processing and data management services.

C.A.T. oil AG serves oil and gas producers and independent E and P companies. As of Dec. 31, 2011, it had 15 active fracturing fleets and 17 mobile sidetrack drilling rigs. The company was founded in 1991 and is headquartered in Vienna, Austria. C.A.T. oil AG is a subsidiary of C.A.T. Holding (Cyprus) Ltd. It trades at the German stock exchange with the ticker O2C.

3) Calfrac Well Services Ltd. (CFW.TO) provides specialized oilfield services to the oil and natural gas industries in Canada, the U.S., Russia, Mexico, Argentina and Colombia. It offers hydraulic fracturing, coiled tubing, cementing and other well stimulation services. The company also provides pressure transient analysis and production decline analysis; acidizing; commodities and logistics; and well performance analysis and forward planning services. Calfrac Well Services Ltd. was founded in 1999 and is headquartered in Calgary, Canada.

4) Trican Well Services (TCW.TO) is an international pressure pumping company with operations on four continents and corporate headquarters in Calgary, Alberta, Canada. Trican provides innovative, engineered and integrated solutions to its customers involved in the exploration and development of oil and natural gas reserves. Trican is currently the largest pressure pumping service provider in Canada and a leading fracturing company in Russia, with growing operations the United States, Kazakhstan, Algeria and Australia. Trican’s expertise and experience in pressure pumping are some of the most extensive in the industry, with an annual average of more than 8,900 frac jobs performed worldwide in the past three years. Trican has also performed an annual average of more than 9,200 cementing jobs, 3,600 nitrogen jobs and close to 3,000 deep coiled tubing jobs over the past three years, among many other services around the world.

5) Halliburton (HAL) thru Halliburton Eurasia has already significant operations in Russia, Ukraine, Caspian West and Caspian East. In May 2012, the Russian energy giant Gazprom and U.S.-based energy services major Halliburton have signed a strategic cooperation deal to develop and implement new oil and gas technologies in global exploration and production projects. “The agreement sets the framework for the ongoing exchange of information related to oil and gas technologies, for technical training to be provided to Gazprom International by Halliburton, and for the deployment of Halliburton technology on Gazprom International projects,” Halliburton said in a statement.

6) Weatherford International (WFT) is one of the largest oilfield services companies worldwide. It provides equipment and services used in the drilling, evaluation, completion, production, and intervention of oil and natural gas wells worldwide. It operates in more than 100 countries and employes more than 50,000 people.

7) Schlumberger (SLB) is another company that supplies technology, integrated project management, and information solutions to the oil and gas exploration and production industries worldwide. In Feb 2012, Schlumberger announced a new family of drill bits specifically designed to meet the challenges facing Russia’s land basins. The company's subsidiary Smith Bits has unveiled the new Viking Family of drill bits, a technology from the polycrystalline diamond compact (PDC) line of products. The equipment features a cutting structure which increases drilling efficiency at both low torque and low hydraulic power. The equipment improves on standard PDC bits, whose nozzle configurations, Schlumberger says, do not produce enough hydraulic horsepower (HSI) to adequately clean the bit face, resulting in poor rate of penetration (ROP) and frequent bit trips. “Traditional PDC bits do not perform well in many Russian land drilling applications because of low hydraulic and mechanical energy at the bit,” said Guy Arrington, president, Bits & Advanced Technologies, Schlumberger. “The Viking Bits family overcomes these challenges and improves performance with changes in the bit design.” The Viking Bits family of drill bits is designed based on knowledge of lithology and drilling experience in Russia. The bits are manufactured in Russia, Italy and Norway and are available in either steel or matrix bodies.

In Oct 2012, TNK-ВР and Schlumberger have signed a contract to jointly implement a pilot project to develop hard-to-recover hydrocarbon reserves in the Severo-Khokhryakovskoe field in the West Siberia. The new format of cooperation serves to enhance the field production efficiency by increasing production per well and formulating the optimal asset development scenario involving the technology of multistage fracturing in horizontal wells. The companies agreed to jointly prepare and implement a comprehensive production program for the hard-to-recover reserves development. The program will be based on the understanding of the project’s cost efficiency at each of the development stages with a target to increase the oil recovery factor. Under the terms of the contract, Schlumberger will coordinate all operations and provide the entire range of oilfield services within the framework of the project.

The contract includes a provision on the correlation between the contractor’s remuneration and production efficiency. “Developing hard-to-recover reserves is cost efficient only subject to use of advanced technologies and an integrated approach to the development of the entire asset. Our pilot project with Schlumberger in the Severo-Khokhryakovskoe field is a new interaction system for the company under which an oilfield services contractor not only provides the entire range of high-tech services and unique solutions controlling the whole suite of operations but is also economically engaged in getting the best result due to the KPI system,” said Mikhail Slobodin, TNK-BP Executive Vice President, Strategy and New Business Development.

Conclusion

Bazhenov looks to be very promising and it may prove to be the next big oil play worldwide. However "all shale oil projects in Russia remain at very initial stages, and the economic efficiency of their development on an industrial scale has yet not been proven" Capital Investment Finance House analyst Vitaly Kryukov said two weeks ago. He also noted that "Shale oil wells may cost four times more than traditional wells, and the flow rates of these wells are known to decrease during the first years of exploitation. Thus, it requires serious technological solutions to maintain production, Kryukov says. According to him, it will not be possible to simply transfer to Russia the experience of U.S. companies that are actively increasing oil shale production. The geology of such projects is heterogeneous and considerably dependent on the regions themselves; their development has not even been profitable until now".Ilona Raskolnikova from the Russian newspaper Pravda noted last week, "If Mother Nature is not going to easily give up its underground wealth, the potential cost of the development must be seriously considered."The Deputy Minister of Energy of Russia Pavel Fyodorov also noted in May 2012 that “Bazhenov Formation are the most complex argillaceous rocks with low oil content, and extraction of oil from them even more difficult task than extracting oil from shale. Time will tell.

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